"History is a wonderful thing, if only it was true"

Monday, August 09, 2010

Capital Ideas

Agreed - lower taxes on capital and free it up for more productive applications

Fairness and the Capital Tax Fetish - WSJ.com

There are at least four channels through which Mr. Bush's tax reform (proposed and passed) raised the long-run productive capacity of the economy—that is, increased the size of the pie. First, since lower taxes mean higher returns to investors, those investors allocate more funds to corporate capital. Corporations can raise capital for investment more cheaply. As a result, the nation's capital stock and output increase.

Second, reducing or eliminating the differential tax treatment between corporate and noncorporate investments means that investment flows are not channeled artificially by tax considerations and the overall productivity of the economy increases.

Third, lowering or eliminating taxes on capital mitigates distortions in our financial structure. Prior to 2003, equity financing was disadvantaged relative to debt financing, with taxes levied twice, at the corporate level and again at the investor level. Because interest payments to debt holders are deductible at the corporate level, debt financing was taxed only once, at the investor level. This system contributed to over-reliance on debt financing. The 2003 tax cuts reduced this bias substantially. Nonfinancial companies went into the recent crisis with lower leverage as a result, a very good thing.

Fourth, low taxes on dividends encourage firms with few growth opportunities to distribute the funds to shareholders. Those shareholders could then reinvest funds in other, more innovative and productive ventures—another very good thing for economic efficiency and growth.

Putting together the effects of greater capital accumulation and improved capital allocation, I estimated at the Council of Economic Advisers that, despite slightly higher interest rates caused by an increase in government debt, the president's 2003 proposal would raise real GDP permanently by about $75 billion annually.

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